Introduction and background
The Employee Retirement Income Security Act of 1974 (ERISA), as amended, established the legal framework for both defined benefit (DB) and defined contribution (DC) plans in the US. Rapid growth of DC plans began four years later, when the Revenue Act of 1978 was passed; Section 401(k) of the Revenue Act permitted employees to make tax-free contributions to their accounts.
Early on, 401(k) programs were fairly rigid. Employers often made matching contributions to employee plans in the form of company stock, and participants typically had no ability to make changes to these investments. Since DB plans were still the primary source of retirement funds, this limitation was less problematic. In addition, fostering employee loyalty was a key goal of company stock funds. Though ERISA imposed a 10% limit on company stock holdings in DB plans, DC plans were — and remain — specifically exempted from such limitations.
As 401(k) plans grew, company failures attracted more attention to plan-sponsor risks. In the high-profile Enron case, 62% of the company's 401(k) was invested in company stock prior to its fall in December 2001. What's more, the company match — made in Enron stock — couldn't be switched to a different investment vehicle unless the employee was over age 50.
Today's 401(k) plans typically offer more flexibility, lower fees and increased investment options. While the number of plan sponsors that offer employer stock funds has declined, it remains substantial. Motivations for using company stock remain the same: plan sponsors generally do so as a way to increase loyalty among participants and align their interests with those of the company itself. Using company stock may also be financially efficient. Notwithstanding the absence of limits under ERISA on plans that offer a company stock fund, an increasing percentage of plans have imposed sensible limits on investment.
Company stock — legal risks and mitigants: A plan-sponsor perspective
Plan sponsors can substantially reduce their fiduciary risk and eliminate perceived conflicts of interest by hiring an independent fiduciary (IF) to manage their company stock fund. IFs can serve their clients as either an ERISA Section 3(38) investment manager or an ERISA Section 3(21) advisor. ERISA Section 3(38) advisors have three characteristics:
- They can manage or dispose of a plan asset.
- They're registered investment advisors under the 1940 Investment Advisers Act.
- They acknowledge in writing their role as fiduciary on behalf of the plan's participants.
ERISA Section 3(21) advisors, in contrast, don't have decision-making authority. All things equal, hiring an ERISA Section 3(38) investment manager provides plan sponsors a higher level of risk mitigation than hiring Section 3(21) advisors.
The responsibilities. An employer stock fund manager's role and responsibility are generally limited to the ongoing decision that maintaining the fund is a prudent decision under ERISA. In addition, the IF can freeze, set limits on investments in a fund, or — in extreme situations — liquidate the fund. Participants direct purchases of company stock shares, except in the case of company-directed employer stock matching contributions.
The framework. A plan fiduciary, in blessing the inclusion of an employer stock fund as a prudent plan investment option, isn't endorsing the stock as having a return expectation that's better than other alternatives. Instead — and consistent with ERISA — the inclusion of an employer stock fund is viewed as supporting participants' retirement goals and aligning such goals with those of the company. This bar may be a lower, but plan fiduciaries are still obliged to monitor and determine the continued prudence of keeping the employer stock fund in a plan. Plan sponsors do retain the obligation to monitor the IF.
Hiring an IF to oversee and manage the company stock fund is a proven way to reduce plan sponsor risk
This approach has been affirmed as recently as 2022, in Burke vs. The Boeing Company. In this case, the plan sponsor hired an IF to make decisions in relation to Boeing's company stock fund. When the business later faced material challenges — and the stock price dropped — plan participants sued Boeing for their decision to not act to liquidate the company stock fund in light of management's own knowledge of the company's material business challenges. Boeing prevailed in the case; the plaintiff's argument was thwarted by Boeing's years-earlier decision to hire an IF (the IF wasn't named in the lawsuit, so its own monitoring approach wasn't legally tested).
What an IF's service offering — specifically Gallagher's — looks like to a plan sponsor
An IF's obligation to judge the prudence of a particular company stock fund begins the moment it's engaged. When engaged, Gallagher actively monitors the stock each trading day. Gallagher's internal work product includes weekly data gathering and monthly meetings to discuss developments. Gallagher's external work product includes our quarterly reports, which we send to clients. As requested, Gallagher will participate in investment committee calls and vote proxies on behalf of plan participants who own an interest in the employer stock fund.
In the unlikely — but possible — event that Gallagher concludes that maintaining the company stock fund as an investment option is no longer prudent, our commitment is to promptly remove it by liquidating the shares held in the fund. As an ERISA Section 3(38) investment manager over the company stock fund, our process requires the internal approval of Gallagher's own investment committee, which is comprised of senior professionals who aren't on Gallagher's engagement team. While this decision rests solely with Gallagher, we implement it in collaboration with the plan sponsor (this collaboration relates in particular to participant communications and coordination with the plan's record-keeper).
Gallagher's prudence decision focuses on company-specific financial metrics such as liquidity, indebtedness, credit ratings and/or profitability
Gallagher’s ongoing prudence decision is primarily guided by our expectation that a company has the capacity to continue as a going concern. A going concern is a business that will continue to have access to capital and operate. In reaching this conclusion, we rely heavily on the company's own public statements and Securities and Exchange Commission (SEC) filings, most notably the Form 8-K — a so-called "current report," which is required when a company announces a material corporate event that shareholders should know about. Going-concern disclosures are typically made in a Form 8-K filing. Also, the Form 10-K filing — the annual report — includes a list of risk factors that management considers material. Finally, Form 10-Q reports note changes in the corporate risk factors, which may also be relevant in our prudence determination. Gallagher obtains this information like any other external investor; our relationship with our plan sponsor client doesn't afford us access to material non-public company information.
For more information about Gallagher Fiduciary Advisors, LLC, and the services it provides as an independent fiduciary to manage and monitor employer stock held in your plan, please call Area Senior Vice President and Area Counsel Darin Hoffner directly at (212) 918-9662.